Doing good for the environment is just one of the incentives for exploring this type of financing.
When the European Investment Bank issued the world’s first green bond in 2007, its name—the Climate Awareness Bond—provided a strong hint about the purpose of the then-nascent financial instrument.
Fast forward to today, when green bonds are regularly issued by governments and private corporations to underwrite sustainable infrastructure projects, such as the construction of renewable energy power plants and energy-efficient buildings.
“There have been steady increases in green bond issuances,” says Julz Burgess, head of Institutional Services at Regions Bank. While less than $8 billion in green bonds were issued in 2012, green bond volumes reached $946 billion in 2023, as companies look to finance capital goals while making a positive impact on the environment.
Green bonds hit the mainstream
Over the past decade-plus, the popularity of green bonds has accelerated dramatically and been marked by some high-profile issuers. For instance, cities like Seattle, Cleveland and Washington, D.C., have issued green bonds to improve transportation and water quality. Apple has issued a number of green bonds including a $4.7 billion green bond in 2022 to finance its clean energy and environmental projects. Fannie Mae has issued more than $100 billion in green bonds over the last decade to raise money for more sustainable housing communities. And Verizon has issued $6 billion in green bonds since 2019, with $994 million in proceeds from a 2023 bond going toward renewable energy efforts.
While the drivers of green bond expansion include the need to finance projects that result in lower greenhouse gas emissions and improved environmental sustainability, the industry has also evolved as it has matured.
For example, instead of just the single umbrella term of green bonds, this category of financial instruments has broadened to include sustainable and social bonds. Each of these categories has unique characteristics and are tracked individually.
- Green bonds fund projects that have specific and clear environmental benefits.
- Social bonds finance initiatives that seek beneficial social outcomes, such as the construction of affordable housing.
- Sustainable bonds are a hybrid of green and social bonds, funding projects such as the construction of affordable, energy-efficient housing complexes that include rooftop solar.
In terms of volume, environmentally focused green bonds are the largest of the three bond varieties, Burgess says, followed by sustainability bonds and social bonds.
A green premium dependent on performance
What accounts for the rising issuance of green, social and sustainable bonds? While working toward environmental and social objectives is foundational to the bonds, issuers are also motivated by the fact that buyers may be willing to accept a lower interest rate compared to traditional bonds for the opportunity to support a cause they believe in. This so-called green premium results in lower borrowing costs for issuers and is the result of this supply-and-demand dynamic.
“There is significant demand for green bonds as evidenced by issuances frequently oversubscribed,” says Burgess. “This benefits the issuers by helping to keep costs of capital low.”
There are nuances to the green premium, however. Interest rates can increase when a green bond issuer does not achieve their objective. For example, a utility may issue a green bond to finance reductions in greenhouse gas emissions. If the utility does not achieve the level of reduction it scoped for, the interest rate may rise. “If they don’t meet the criteria, there is an additional interest rate tacked on top,” says Burgess. “The investors benefit, but it goes against the whole premise of the bond issuance, which is to achieve a net positive environmental outcome.”
A permanent pillar
Green bonds have changed in meaningful ways since their inception, and they will likely continue to evolve. “These bonds are still very young in the grand scheme of bond issuing,” says Burgess. “The subclassifying we have seen may continue, giving the investment community better information about what each bond is for and is supposed to accomplish.”
What’s increasingly clear is that green, social and sustainable bonds aren’t going anywhere. One reason to be confident in that conclusion is because funds that have been investing in green bonds have experienced asset growth, meaning more people are investing in them. “Money funds comprised of a lot of traditional bonds have seen outflows in the past decade,” says Burgess. “Funds that have specifically been investing in green bonds have seen inflows.”
Start today
- Read more: Creating an effective CSR strategy: 7 top tips.
- Learn more: Listen to a podcast on how ESG may affect your business.
- Take action: Learn how the New Markets Tax Credits program can help you raise money to serve communities in need.
